Why Bankrupt A Corporation? - Bankruptcy In Brief

Good question! Since a corporation doesn’t get discharge in Chapter 7, when does it make sense to file bankruptcy for a corporation?

Why not simply close the doors, sell the assets, and allow the state to terminate the corporate existence?

Advantages to corporate bankruptcy

In our view, there are only a couple of situations when it is advantageous to file a Chapter 7 for a corporation:

When a creditor is poised to lien or levy on assets that could be used to pay debts for which the shareholders or officers are personally liable, such as trust fund taxes .
When the services of a bankruptcy trustee are desirable to liquidate assets and oversee the winding up of the business, freeing the corporation’s officers to seek employment, etc.
When filing bankruptcy may discourage creditor suits against the corporation which often involve the officers and shareholders personally, regardless of whether the officers are legally liable for the debt.

Note that generally each of those advantages accrue to the shareholders of the corporation. The corporate shell will still be encumbered with the unpaid debts since the corporation doesn’t get a discharge in Chapter 7.

Disadvantages of filing

If the shareholders hope to avoid individual bankruptcy filings for themselves, filing bankruptcy for the corporation can complicate matters.

A bankruptcy trustee is tasked with investigating the corporation’s activities and its financial dealings with the insiders.

At best, a corporate bankruptcy trustee can make demands on the officers for time and records to explain the corporation’s situation. At worst, the trustee may bring suit against the officers for the recovery of loans or advances made to the officers.

A trustee can claw back payments made on legitimate debts owed by the corporation to insiders, or to creditors whose debts the insiders have guaranteed.

In short, issues that aren’t “issues” outside of bankruptcy, can become troublesome if the corporation files bankruptcy.

The most important thing if you wind up outside of bankruptcy is that the debts of the corporation be paid in full before the shareholders get anything on account of their shares.

It’s OK to pay insiders for the debts the corporation owes them, along with third party creditors. Equity holders (shareholders) only get money for their ownership interest after creditors are paid.

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